By Promit Mukherjee and Howard Schneider OTTAWA/WASHINGTON, March 18 (Reuters) - The U.S. Federal Reserve and Bank of Canada both struck hawkish tones on Wednesday in the face of surging energy prices
Central banks stand ready to tackle war-led inflation
Global Central Bank Responses to War-Induced Inflation Risks
By William Schomberg and Balazs Koranyi
LONDON/FRANKFURT, March 19 (Reuters) - Top central banks said on Thursday they stood ready to tackle any surge in inflation with tighter policy, as an escalation in the Iran war put the Middle East's vital energy infrastructure in the line of fire and pushed fuel prices higher.
In a rare coincidence of the monetary policy diary, central banks of the United States, Japan, Britain, Canada and the euro zone - effectively the Group of Seven (G7) nations - convened this week, as have counterparts from several emerging economies.
Policy Actions and Inflation Concerns
After facing criticism they acted too late to tame a post-COVID jump in inflation exacerbated by the Russian invasion of Ukraine in 2022, policymakers are determined to rein in prices without derailing still-patchy economic growth - and above all to avoid a "stagflation" mix of recession and price surges.
The U.S. Federal Reserve and the Bank of Canada on Wednesday both opted to hold interest rates steady, as did the Bank of Japan, Bank of England, European Central Bank and the central banks of Switzerland and Sweden on Thursday.
Yet they made clear they are on alert, wary that rising energy prices could spark a wave of inflation across the wider economy if, for example, it starts to prompt higher wage demands by households fearful of losing purchasing power.
ECB's Position and Outlook
"The war in the Middle East has made the outlook significantly more uncertain, creating upside risks for inflation and downside risks for economic growth," the ECB said.
In her press conference after the decision, ECB President Christine Lagarde said the euro zone was resilient and that low inflation meant it was "well positioned" to deal with what she called "a major shock that is unfolding".
The central bank raised its forecast for inflation this year to 2.6% - above its 2% target - and released scenarios under which inflation could fall back down again if the shock proved temporary but rise to 4.8% next year if disruption continued.
In the absence of a quick resolution to the conflict, ECB policymakers are likely to start a discussion on interest rate hikes in April and possibly tighten policy at their subsequent meeting in June, three sources told Reuters Thursday.
Bank of England's Approach
Commenting on the unanimous decision by the Bank of England's policy-making committee to keep rates on hold, BoE Governor Andrew Bailey said the bank would have to respond to a persistent impact on UK inflation.
But he played down expectations on markets for a sharp tightening in policy as traders priced in two 25-basis-point rate hikes by year-end, up from just one prior to the meeting.
"I would caution against reaching any strong conclusions about us raising interest rates," Bailey said in an interview pooled for British broadcasters. "Today we've given a very clear message. The right place to be is on hold."
US Rate Hike and Global Market Reactions
Escalation of Conflict and Energy Prices
US RATE HIKE STARTS TO GET PRICED IN
Marking an escalation in the war that began on February 28, Iranian strikes since Wednesday have caused extensive damage to the world's largest gas plant in Qatar and hit other Gulf infrastructure following Israeli attacks on its own gas facilities.
Such strikes already make it more likely that the global economy will have to grapple with longer-term damage to energy supplies.
Federal Reserve's Stance
Federal Reserve Chairman Jerome Powell noted that quantifying the hit from higher energy prices was impossible.
"In the near term, higher energy prices will push up overall inflation, but it is too soon to know the scope and duration of the potential effects on the economy," Powell said after the Fed's 11-1 decision to hold rates in the 3.50%-3.75% range.
His reluctance to say that risks of a weakening job market posed a greater risk to the Fed's objectives than inflation helped erase market bets on rate cuts this year and well into next.
Financial markets on Thursday even reflected a rising chance of a Fed rate hike, though traders cautioned against taking that pricing too literally given the volatility in oil prices that has contributed to that trade. Brent futures LCOc1 shot up past $119 a barrel overnight, though by Thursday had eased to around $108.50.
Bank of Japan and Bank of Canada Perspectives
In Tokyo, Bank of Japan Governor Kazuo Ueda said the BOJ would not rule out a near-term rate hike if the expected hit to growth from surging oil costs proves temporary, and does not derail progress in durably hitting the bank's price target.
"We need to be mindful that recent developments come at a time when companies are already actively pushing up prices and wages, which suggests they could pass on costs more aggressively than after the war in Ukraine," Ueda told a news conference.
Bank of Canada Governor Tiff Macklem struck a similar note: "If energy prices stay high, we will not let their effects broaden and become persistent inflation," he said.
Growing 'Stagflation' Risk?
Other Central Bank Actions and Market Impact
GROWING 'STAGFLATION' RISK?
Earlier this week the Reserve Bank of Australia hiked rates to a 10-month high and warned of a "material" risk to inflation from the oil price spike.
Even Brazil's central bank, with one of the highest rates of all major economies, opted for a cautious 25-basis-point cut to a benchmark 14.75% rate - a smaller cut than initially expected.
On Thursday both the Swiss National Bank and Sweden's Riksbank kept policy rates on hold, flagging the uncertainty of how the war will end up impacting the economy.
European markets fell sharply on Thursday and U.S. stock futures dipped as the attacks on energy infrastructure pushed benchmark Brent oil prices above $119 a barrel.
Market Sentiment and Strategic Outlook
"This latest escalation feels like a turning point for markets because the conflict is no longer just about military headlines or Strait of Hormuz closure," Charu Chanana, chief investment strategist at Saxo in Singapore, said.
"It is now hitting the plumbing
